Update — FT Alphaville has heard that the answer to this question is in fact… yes. See below for more details.
The official EBA numbers on European bank capital shortfalls are out. In aggregate it’s €114.7bn.
You can read up on them here and see a country-by-country list below, but we just want to focus on the EBA’s views about deleveraging. That is, banks stopping lending or selling assets as a way to meet the EBA’s nine per cent capital ratio target. Which has been a bit controversial.
The EBA release is quite curiously worded on this:
National supervisory authorities may, following consultation with the EBA, agree to the partial achievement of the target by the sales of selected assets that do not lead to a reduced flow of lending to the EU’s real economy but simply to a transfer of contracts or business units to a third party. These latter actions are not considered as deleveraging for the financial system as a whole, as assets are transferred to third parties rather than reduced. Reductions in risk weighted assets due to the validation and roll-out of internal models to additional portfolios should not be allowed as a means of addressing a capital shortfall unless these changes are already planned and under consideration by the competent authority. Banks should first use private sources of funding to strengthen their capital position to meet the required target, including retained earnings, reduced bonus payments, new issuances of common equity and suitably strong contingent capital, and other liability management measures.
Though it seems there are some loopholes. This is a footnote in the EBA formal recommendations:
Ordered deleveraging processes already formally agreed with international organisations or EU institutions before 26 October 2011 should, if submitted to and monitored by the competent authority, also be allowed. The same conditions would apply in some cases to formal restructuring plans.
The recommendation also warns against “excessive” deleveraging. In its overall release though, EBA wants to make its stance on asset sales clear:
Pursuant to the Recommendation, the national authorities will require banks to submit, by 20th January, their plans detailing the actions they intend to take to reach the set targets. These plans will have to be agreed with National authorities and reviewed, shared and consulted on with the EBA and with other relevant competent authorities within colleges of supervisors as appropriate. National authorities will seek to ensure that throughout the colleges’ discussions of capital plans the need to maintain exposure levels of banking groups in all Member States is taken into account, recalling that if and where necessary the EBA will use its mediation role to that effect.
The EBA previously already identified a lack of access to term funding as a serious hindrance to banks continued lending activities and agreed the measures announced today as parts of broader efforts to restore confidence to the EU banking system with the aim of maintaining lending into the real economy. National authorities and the EBA will seek to ensure that the actions taken to comply with the set requirements do not lead to significant constraints on the credit flow to the EU real economy.
First, does anyone detect a slight geographical blind spot here?
They keep mentioning the EU and EU Member States but not the rest of the world. So, is the rest of the world safe from a credit crunch caused by European banks getting rid of their loans, or not? It doesn’t look like it. It doesn’t seem to be a very fair deal for Asia, or the United States. The Fed having gone to so much trouble to ease pressure on funding markets from European banks selling US dollar assets does of course show that this isn’t really a surprise. Those “axe sheets” of European banks’ Asian loans doing the rounds also show it isn’t a surprise. But still, it’s pretty EU-centric…
Update — OK, so on asking around about this language, we’ve heard that banks’ deleveraging activities under the capital plans they submit to regulators must also take account of the rest of the world after all. This still leaves questions over how far European regulators can enforce rules on events which take place outside Europe, but it seems banks will have to submit plans that detail what they deleverage, and how. In particular, whether asset sales would lead to reductions of assets, or would pass to third parties more or less untouched (which is what the EBA will be demanding of banks).
By contrast, distressed eurozone sovereign debtors seem (relatively) safe from banks selling their debt in order to meet the EBA’s capital target (as opposed to all the million other reasons banks might sell). This is for obvious reasons — at current price levels, the banks will record massive losses — but also, regulators won’t allow it. The following comes from the Bank of Italy’s statement on the EBA exercise:
Sales of sovereign bonds will not alleviate the buffer requirement to be achieved by June 2012, but – given the current market conditions – would only cause the materialisation of losses in banks’ balance sheets…
…sales of sovereign bonds will not alleviate in any way the buffer requirement banks are asked to achieve by June 2012. Only the narrowest of actions that impact risk weighted assets (RWAs) will be permitted, such as the validation and roll-out of appropriate internal models where these are already planned and under consideration by the competent authorities and the sale of an organised business or whole lines of business. These actions are not considered as deleveraging for the financial system as a whole; in particular for asset sales, assets are transferred to third parties rather than reduced.
But that’s the second curious thing. Does this stuff read as disallowing “natural” deleveraging — banks simply not making new loans (i.e. not selling assets they already have)? We’re not sure.
Finally, there is so much about regulating deleveraging here, but there are no provisions on how public capitalisation of banks might have to proceed. Interesting, as it seems there are few other options — if deleveraging isn’t apparently welcome.
For example, when it comes to banks doing cash calls — Commerzbank assured everyone this evening that it was keeping its options open on the possible issuance of “equity capital instruments”. Shareholders aren’t. Its stock was down 11 per cent on Thursday. The BdB, the German banking association, thundered that the EBA “hasn’t contributed to market stabilisation” even before the full EBA results came out.
It’s just an example of how issuing capital will clearly prove problematic relative to deleveraging… somewhere.